Bitcoin and Government Shutdowns: Amateur Hour

One central mystery behind crypto currencies is “Who owns/trades them?” Here’s one way to look at it:

By one estimate there are 22.4 million bitcoin wallets, and since there are only 17 million bitcoins outstanding, the math says the average wallet holds less than one coin.

Further, a handful of owners (the Winklevoss twins and bitcoin founder Satoshi Nakamoto, to name two) likely hold 1 million plus each, so the median wallet holding is therefore more like 0.5 bitcoin or less.

The conclusion: much of bitcoin ownership is likely atomized among a large base of individual owners who each own a fraction of a coin.

Another way to look at the question is to analyze the price action around specific events, such as the US government shutdown at midnight last Friday/Saturday am. Large capital markets like global equities and fixed income largely ignored the deadline last week, with stocks happily rallying into the close on Friday. Institutional investors know shutdowns are a somewhat regular occurrence (18 since 1977), and pay them little mind.

Bitcoin and other crypto currencies, however, rallied sharply from 11:30pmon Friday night through Saturday afternoon (DC/East Coast times). Here’s a breakdown of the price action:

Bitcoin rallied 7.8% from 11:34 pm (Friday) to 12:04am (Saturday). It tacked on another 2.1% through Saturday afternoon.

Ethereum rallied a similar amount – 10.6% – from Friday at 11:30pm to Saturday afternoon.

Bitcoin Cash rallied by 19.3% from late Friday evening into Saturday evening.

Ripple – which has been trading on its own fundamentals over the last few weeks – did not see any appreciable move. The three cryptos we cite here are, however, well over half (59%) of all currencies outstanding by value.

If you’re thinking “Amateur hour!” we must agree. Anyone with capital markets experience knows that US government shutdowns are largely meaningless in the context of financial asset values. Getting sucked into a series of seemingly ominous headlines that smarter players already understand is a typical rookie trading mistake.

By Sunday afternoon all the gains we cite above were gone, and in that price action lies a few lessons about crypto currencies:

#1. This is still a very inefficient market. A 10% round trip in 36 hours shows that well enough. Individual (i.e. not institutional) bitcoin traders just got schooled in how markets actually work. That’s healthy, by the way, even if the cost of tuition in trading is always high.

#2. While futures may give some players the opportunity to short bitcoin, that doesn’t help price discovery when those markets are closed. The futures markets were closed at midnightFriday, so there was no chance to fade the rally using this instrument.

#3. While bitcoin traders who bought on the shutdown headlines may have purchased at bad prices, their behavior highlights a belief that “Stateless” currencies are a hedge against the political vagaries of state-sponsored stores of value like the US dollar. That is something of an article of faith in the crypto community, and especially with bitcoin. But while our midnight traders got this one wrong, they did show their hand in a useful way. Remember that the first bitcoin mined 9 years ago this month had a line of text attached: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. Bitcoin was born in a period of genuine anxiety over the stability of the global financial system.

So does the Friday evening price action in bitcoin/cryptos tell us anything about how these instruments will trade in the face of a larger (and more real) crisis? I think it does. Keep in mind this is a very small piece of the world’s financial assets – just $550 billion as of today. And the base of owners is equally tiny – just 22 million wallets. And we know from the past year that bitcoin’s price is closely tied to adoption rates.

In the face of a “Make believe” crisis they rallied 10% in less than 24 hours.Granted, cooler (and more rational) heads correctly prevailed. But what happens if/when an actual geopolitical/financial crisis occurs? The price action from this small case study shows what happens.